By Jean-Pierre Laporte
Special to the Financial Independence Hub
The Great Recession of 2008 had many consequences, but in the world of pensions, it truly highlighted the chasm separating private-sector from public-sector retirement plans.
The “Great Divide” boils down to this: civil servants have back-stopped, defined benefit pension plans that will provide a comfortable level of pension benefits in retirement, whereas the tax payers responsible to fund such great plans are largely relegated to RRSPs with much lower contribution limits and a limited ability to weather financially volatile markets.
For most, this state of affairs is immutable and lamentable. For those who have made pensions their passion or profession, there are solutions. The difficulty is to make them accessible to the majority, who happens to be the marketplace. What are some of these solutions that put the private and public sectors on an even keel?
The Dividend Route
Borrowed from the world of accounting, one strategy advocated over the past few years is to use the corporation as a pension fund and to take only ‘income’ and pay tax thereupon, when a dividend is declared. This, combined with different classes of shares to children and corporate-class securities, offers a great way to defer tax and to control the amount of tax paid in retirement.
Insured Retirement Plans
Borrowed from the world of insurance, one poorly-known solution is that of an insured retirement plan (“IRP”). Here, one variant is to have the corporation take out life insurance via an universal life policy on the life of the plan member, with the corporation itself named as the death beneficiary.
Additional premiums can be made to the policy (to go above the cost of insurance) and invested in an account within the policy that is not subjected to Part I tax (only a 2% insurance tax). Since the investment account can be posted as collateral with a lender, the policy owner can borrow against the policy; and since a line of credit is not income, in effect a tax-free pension plan has been set in place with a large tax-free transfer of the death benefit to the children/shareholders of the company.
Personal Pension Plans
Borrowed from the world of pensions is the Personal Pension Plan (“PPP”), a combination registered pension plan for single entrepreneurs. The PPP is funded by the company, much like the IRP, but the contributions trigger tax deductions, similar to what occurs with an RRSP, except that the level of contributions exceeds RRSP limits and that a series of additional tax deductions are also available:
A) Corporate contribution to assist the member in purchasing years of past service to increase the promised pension in retirement
B) Terminal funding to allow the member to enhance the basic pension with ‘ancillary’ benefits such as indexing, CPP temporary bridge pension and early unreduced pension benefits.
C) Fees (investment management and administration) are fully tax deductible, including any RRSPs transferred into the PPP’s unlocked account.
D) Special Payments, where the assets of the pension fund do not meet the prescribed rate of growth (7.5%)
E) Interest paid to a lender to make contributions to the pension plan – also tax deductible.
Thus, it is quite easy to see that with the right combination of solutions, a private-sector actor can build a retirement strategy that is as generous as a public sector pension, but with additional bells and whistles to go with it.